richard a. kimball, jr. - rebuilding america: the role of foreign capital and global public...

8/10/2019 Richard A. Kimball, Jr. - Rebuilding America: The Role of Foreign Capital and Global Public Investors

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Reuters/ Robert Galbraith A CalTrans worker di splays a new section of roadway on t he San Francisco Bay Bridge.

Rebuilding America:The Role of Foreign Capital and

Global Public Investors

Darrell M. West, Rick Kimball, Raffiq Nathoo,

Daniel Zwirn, Vijaya Ramachandran,

Gordon M. Goldstein, and Joel H. Moser

March 11, 2011


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Rebuilding America: The Role of Foreign Capital and Global Public Investors

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E X E C U T I V E S U M M A R Y

overeign wealth funds, foreign state managed social security plans, foreigncurrency reserve funds, foreign government employee pension funds, state-

controlled operating companies and other foreign investing vehicles today

collectively control trillions of dollars in assets and are projected to maintain significantgrowth over the next decade. These disparate foreign government entitiescharacterizedin this report as Global Public Investors (GPIs)are becoming increasingly influentialplayers in the world economy. In the volatile contemporary global financial environment,the investment strategies of these foreign entities will impact capital flows and affect

markets around the world.

Despite their growing salience in the international economy, policy-makers and

political leaders in the United States have only a partial understanding of the investingpractices, management and governance of these sources of foreign capital. There is finiteknowledge regarding their strategic, political and regulatory implications and limitedappreciation of their enhanced role in the deployment of global capital.

In this report, participants in the Brookings Institution Project on Foreign Capital andGlobal Public Investors have drawn on a variety of resources regarding how this class ofinternational financial actors defines its core objectives, assesses and manages risk, and

deploys capital.1We attempt to analyze what foreign capital and GPIs mean for the

United States and what regulatory, political, and governance issues flow from theirexpanding size and pace of investment activity. In preparing this report, project

participants interviewed senior investment professionals from sovereign wealth funds andother GPIs; consulted investment bankers who originate and execute investment

opportunities for GPIs on a global basis; engaged some of the worlds leading publicpolicy researchers tracking the activities of sovereign wealth funds; held off-the-record

conversations with former senior U.S. government officials; and also analyzedgovernment data, surveyed think-tank literature and reviewed recent media and academic

articles.2

Our goal is to fill the gaps in understanding within the policy and politicalcommunities. We aim to look beyond current paradigms of foreign direct investment inthe United States to explore new models of how international entities, including sovereign

wealth funds and other GPIs, might invest capital that would earn competitive risk-adjusted returns and also fund vital public priorities during a protracted period of budgetdeficits and dramatically enlarged national debt.

Based on these disparate sources, we seek to discern broad patterns of responseby GPIs to the recent financial crisis and to assess the impact on long-term American

interests.

1The authors would like to gratefully acknowledge the substantive contributions to this study made by Derek

Kirkland, Alicia Ng, Ken Miller, and Jenny Lu, and the valuable assistance provided by Mark Murtagh on

global and American infrastructure investment. Views of the authors are their own and do not reflect the

views of the institutions with which they are affiliated.2Where a publicly available source can be cited, this report attempts to do so. But some of the analysis

contained here flows from discussions with experts who required that their views and opinions be conveyed

privately and not be publicly attributed to them.

S


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With Americas 2009-10 federal budget deficit projected to total $1.5 trillion and its

public debt expected to rise to about $13.5 trillion this year, the need for foreigninvestmentproperly focused and thoughtfully structuredis high. This report therefore

identifies potential approaches to address long-term financial needs in partnership with

foreign capital.Participants in this study understand the anxiety triggered by certain kinds of foreign

capital investment in the United States. Many worry about the influence of non-U.S.

money and question the investment strategies and goals of foreign entities. It was notlong ago, for example, that an attempted investment in Americas shipping infrastructure

by DP World, a state-owned company in the United Arab Emirates, sparked a nationwidebacklash as critics emphasized the potential national security risks of a foreign entitymanaging maritime trade hubs. This report acknowledges that there are certain sectorsthat may be perceived as particularly sensitive, such as the military and defense

industries, as well as selective natural resources and technology sectors and some U.S.infrastructure assets.

Yet there is an economic logic for expanding global capital investment in the U.S.According to the Congressional Research Service, foreign investment declined sharplyafter 2000, when $300 billion was invested in U.S. businesses and real estate. In 2008

foreign investment in the United States had surged to $351 billion but fell in 2009 to $269billion, far below its peak.

3

Our research dispels a number of myths and misperceptions about foreign capitalpractices and investment priorities. Based on the multitude of data-points we examined,

this analysis concludes that the preponderance of sovereign wealth funds and otherGlobal Public Investors are inherently cautious, focused on capital preservation, assetdiversification, predictable returns, and the mitigation of political risk. As noted, mostlimit their equity ownership stake in public companies, financial institutions and private

businesses to minority status and eschew direct management responsibility.

In the aftermath of the financial crisis and a severe recession,the United States has pervasive capital needs for infrastructure development to enhanceU.S. economic competitiveness, business investment to spur job creation, and

technological innovation to fuel growth. There are multiple examples of other nations,such as Canada, the United Kingdom and Australia, that leverage foreign investment in

infrastructure and other projects to finance and advance critical national priorities. Whilestate governments generally preclude direct control or full ownership of those assets byforeign entities, minority investment agreements have proven both durable and mutuallyadvantageous.

Based on our review of the practices and policies of Global Public Investors, we make

a number of recommendations intended to improve the climate for foreign directinvestment in the United States and strengthen the broader relationship betweenAmerican policy-makers and political actors and foreign authorities with responsibility forthe allocation of state sources of capital. Among our central conclusions are the following:

3Foreign Direct Investment in the United States: An Economic Analysis, Congressional Research Service,

February 1, 2011.


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Acknowledging the Value of Foreign Capital to the United States: Americas

massive public debt and chronic budget deficits, compounded by projectedperiods of limited GDP growth of 2 to 3 percent annually, underscore the need for

foreign capitalproperly structured and deployedto meet vital needs and

promote long-term economic development. Xenophobic or paranoid reactions toforeign capital are not warranted given the generally conservative investment andmanagement practices of leading Global Public Investors.

Driving Policies and Programs that Facilitate GPI Capital Deployment: TheUnited States requires enhanced policies and innovative new programs that

encourage GPI capital deployment to meet both public and private sector needs.America has a long tradition of foreign investment from European nationsthroughout our history, Japan in recent decades, and a variety of countries duringthe contemporary period. Today a surplus of capital from Global Public Investors

is deployed around the world, its allocation determined not simply by the prospectof favorable risk-adjusted returns but also by calculations about the political and

regulatory environment of host countries. America must compete aggressively inthe contest for capital from the new class of Global Public Investors that aredeploying greater resources in a diverse range of asset classes and public-privatepartnerships. In an integrated global economy public capital, like private capital,

will inexorably find its highest and best use, based on the competitive dynamics ofthe global investment marketplace. The benchmarks for global capital investment,however, include but are not necessarily limited to the highest risk-adjusted

return. Other inducements, protections and considerations that government canstructure can influence investment decisions. The United States therefore requires

a dynamic twenty-first century policy architecture to realize the potentialrepresented by the increasingly broad reach of GPI capital deployment.

PromotingInvestment in U.S. Infrastructure: It is widely acknowledged that theUnited States is in the midst of a crisis afflicting its outdated and crumbling

national infrastructure, the rehabilitation of which is vital to American economiccompetitiveness. It is similarly acknowledged that federal and state sources of

funding, today exacerbated by a growing pattern of acute municipal deficits, arewholly inadequate to address the scope of the challenge. Foreign capital, includingsovereign wealth funds and other Global Public Investors, can aid infrastructuredevelopment through direct investment, public-private partnerships and other

financial vehicles that facilitate GPI investment in local, state, and federalinfrastructure projects. While the need for policies to support infrastructuredevelopment is acute, there may be a corresponding opportunity to attract GlobalPublic Investor capital. As an asset class, infrastructure has attributes historicallyattractive to Global Public Investors, including relative transparency and

predictability of returns on invested capital due to generally stable cash flows.Innovative public policies and government sponsored programs that support andencourage such investments could further attract Global Public Investors to U.S.infrastructure development.


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Supporting Green Technology Development: Foreign capital from Global Public

Investors can play a constructive role in helping to finance a Green Bank for thedevelopment of low-carbon and energy efficiency technologies, including the

provision of financing for companies not currently well served by the conventional

project finance market. In addition to emerging as a vibrant new industry withpromising long-term growth prospects, clean technology or cleantechinvestment has become a focal point of environmental policy ambitions for both

industrialized and emerging market economies. A Green Bank financing vehiclebacked by the government with loan guarantees buttressing private capital

investments could be potentially attractive to Global Public Investors.

Encouraging Best Practices: As Global Public Investors become increasinglycentral players in the international economy, expanded implementation ofprinciples of transparency and disclosure will help to alleviate the political

tensions surrounding their investing agenda and practices. Today there is greatvariability in adherence to the so-called Santiago Principles adopted on a

voluntary basis in 2008 by the countries represented in the International WorkingGroup of Sovereign Wealth Funds sponsored by the International Monetary Fund.Recently, some of the worlds most prominent GPIs issued their first publicdisclosures. In 2010, the China Investment Corporation filed its first voluntary

report with the U.S. Securities and Exchange Commission outlining its Americanholdings and the Singapore Government Investment Corporation and Abu DhabiInvestment Authority published their first annual reports.Looking ahead, it is

possible to imagine that increased transparency by GPIs could be incentivized bynew marketplace mechanisms that reward relatively greater levels of disclosure.

Stimulating Dialogue and Building Partnerships: To foster a climatethatencourages investment and partnership between Global Public Investors and theUnited States, transparency and disclosure are principles that must be embraced

by all relevant stakeholders. Amidst a period of legislative and policy activism on

financial regulation in Washington, one of the most common concerns weobserved was a lack of clarity among GPIsabout the long-term regulatory and

political environment in the United States.4

4This frustration was expressed repeatedly but privately in multiple confidential discussions with senior

managers of Global Public Investors, including sovereign wealth funds and state foreign reserve funds.

Administration and congressional

actors in Washington have ad hoc and extremely narrow channels ofcommunication with Global Public Investors, which in turn exacerbates

uncertainties about the rules and regulatory structures that will govern foreigndirect investment in the United States. The absence of meaningful dialogue furtherlimits the evolution of potential investment partnerships and new innovations inforeign financing mechanisms to deploy capital from GPIs in the United States. To

remedy this problem, one of the most important yet easily implementedrecommendations of this study is to create the Global Public Investors Roundtable,an informal group of administration policy-makers from the White House,

Treasury, State and Commerce Departments and a range of congressional actors


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and their staff from both sides of the aisle in Washington who would meet with

the worlds leading Global Public Investors, Sovereign Wealth Funds andrepresentatives of other international financial institutions on a periodic basis to

share information and stimulate dialogue on economic, regulatory, tax, national

security and political issues central to foreign investment in the United States. Suchmeetings could engender dual benefits: foreign investors could gain greater clarityinto rules, regulations and policy directives that would contribute to predictability

and stability while government actors could develop more robust strategies toencourage sources of foreign direct investment that have a near-term impact on job

creation and competitiveness.

The following analysis describes the sources of foreign capital and the functional andgeographic diversity of Global Public Investors, including modes of regulation,mechanisms for capital deployment, and contrasting investment strategies. We look at the

impact of the financial crash on investment horizons and risk assessment, and note thecaution many GPIs observed in the aftermath of the financial crisis. In examining the

behavior and investment philosophies of Global Public Investors, we investigate commonconcerns ranging from the perceived political interests of state investors, the scope anddegree of control associated with equity stakes, and relative levels of fund transparency.In general, we find limited evidence of political interference in investment decisions, a

tendency to avoid controlling stakes in foreign companies and some improvement in fundtransparency and disclosure. In the remainder of the paper, we explore the role thatGlobal Public Investors can potentially play in vital spheres of the U.S. economy, such as

investments in infrastructure development and low-carbon and energy efficiencytechnologies. Our analysis concludes with a proposal to stimulate a substantive and

continuing dialogue between Global Public Investors and the American political andpolicy communities to explore issues of common interest related to foreign capital

investment in the United States.

Sources of Foreign Capital

Our review surveyed several types of Global Public Investors, including state-ownedenterprises, foreign government employee pension and retirement funds, state foreign

exchange funds and the proliferating global order of Sovereign Wealth Funds increasinglyconcentrated in East Asia and the Persian Gulf and Middle East regions. Each type of

investing entity embodies different objectives and management practices, and elicitsvarying degrees of scrutiny and controversy, depending on their goals and practices.

State-controlled and state-owned enterprises (SOEs) are commercial businessesoperated by foreign governments. Russias Gazprom, Brazils Petrobras, Norways Statoil,

and Italys ENI represent large enterprises in the energy sector largely operated bynational governments.5

5 Aldo Musacchio and Francisco Flores-Macias, The Return of State-Owned Enterprises, Harvard

International Review, 2009.

There are over 300,000 SOEs in China alone employing over 75


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million people. For example, Sinopec (the China Petroleum & Chemical Corporation) has

a workforce of over one million, while the China National Petroleum Corporation has alabor force of over one and a half million people. SOEs, heavily represented in the

industries focused on resource extraction, have in recent years emerged as major players

in the global competition for energy and mineral resources.Some governments have public employee or national pension funds that invest capital

in American corporations, buy U.S. government securities, or take positions in a wide

range of investment vehicles. Due to their conservative investment philosophy, sensitivityto headline risk that can stimulate government action and long-term investment

horizon, they are predisposed to conventional portfolio management strategies andtypically decline to purchase controlling interests in individual companies or financialinstitutions and do not seek to exercise management control. One example is SouthKoreas National Pension Service (NPS), the fourth largest pension fund in the world. In

late 2010 an NPS official confirmed that in the following year it would purchase about $10billion in the domestic foreign exchange market and that it would continue to diversify

into foreign stocks and alternative assets, reducing its roughly 77 percent concentration inthe global bond market. NPS manages approximately $272 billion in assets. 6According toa survey by the Organization for Economic Cooperation and Development (OECD), thedegree of regulation of state pension fund investments varies considerably around the

world.7

The worlds most closely watched investor of foreign exchange reserves is SAFE,

Chinas State Administration of Foreign Exchange. Established in 1997, SAFE todaymanages an estimated $347 billion through the SAFE Investment Company, based inHong Kong.

8In addition to allocating state currency reservesa significant portion of

which have historically been allocated into high-grade American debt, specifically U.S.

treasuriesSAFE is also mandated to draft standards and policies for the foreignexchange administration system, implementing risk management procedures and

monitoring of balance of payments. According to a 2009 report, SAFE lost tens of billionsof dollars in an ill-timed effort to hedge its concentration in American debt securities witha diversification push into global equities just before values plummeted. By June 2008,Chinas total holdings of U.S. equities exceeded $100 billion, more than triple the total of

one year earlier, according to an annual survey published by the U.S. Treasury. SAFEbuilt up one of the largest U.S. equity portfolios of any foreign government entityinvesting abroad, including the major sovereign wealth funds, said Brad Setser, a former

Senior Fellow at the Council on ForeignRelations, who estimated China lost $80 billionbefore global equity markets stabilized.9

The most prevalent mechanism for the deployment of state capital by Global PublicInvestors are Sovereign Wealth Funds (SWFs), which have existed for decades but have

6NPS May Buy $10 billion in South Korea Forex Market in 2011Official, Reuters, November 30, 2010.7Organization for Economic Cooperation and Development, Survey of Investment Regulation of Pension

Funds, February, 2010.8 Preqin Investor Intelligence Profile, 2010.9 China Lost Billions Buying Stock Just Before Crash, by Jamil Anderlini, Financial Times, March 15, 2009.


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grown dramatically in recent years. Sovereign Wealth Funds were initially conceived as

vehicles to invest the proceeds generated by resource-rich states. The first SWF, theKuwait Investment Authority, was created in 1953 to invest the countrys oil revenues. But

some of the worlds largest SWFs are not dependent on commodity exports. Since 2005 at

least 17 new SWFs have been created, including the China Investment Corporation(CIC), which was launched in 2007 with a mandate to manage a portion of Chinasforeign exchange reserves. CIC has rapidly emerged as one of the worlds largest

sovereign wealth funds, with an estimated $332 billion of assets under management.10

From a functional perspective, SWFs typically fall into four categories. Revenue

Stabilization Funds are created to cushion the impact of volatility in commodity revenuesand stabilize a state governments fiscal balance and broader economy. Future GenerationSavings Funds are designed to build and preserve state wealth over a long-term timehorizon or to cover state pension liabilities. Holding Funds manage a state governments

direct investments in companies, including state-owned enterprises, and are structured tosupport the governments overall development strategy. Finally, as a JP Morgan research

report noted, a fourth category of Sovereign Wealth Funds often cover(s) one or severalof the previous three purposes, but their size tends to be so large that the main objective

becomes optimizing the overall risk-return profile of existing wealth.

Along with Temasek Holdings of Singapore and the Government of Singapore Investment

Corporation, CIC represents an alternative paradigm of Sovereign Wealth Fundsglobalinvesting entities built on the foundation of significant mercantile power and huge export-led growth rather than vast reserves of petroleum. This distinctionbetween commodityand non-commodity investing entitiesdelineates essentially all of the worlds Sovereign

Wealth Funds.

11

Estimates of the aggregate total of Assets Under Management (AUM) of all

Sovereign Wealth Funds are projected to be approximately $4.1 trillion as of the close of2010.

12The estimate is inherently uncertain because some of the worlds largest funds,

such as the Abu Dhabi Investment Authority (ADIA), China Investment Corporation,and Saudi Arabias SAMA Foreign Holdings do not publicly disclose all of their holdings.Despite the imprecision of current estimates, Sovereign Wealth Funds have grownsignificantly since 1990, when their aggregate AUM was a fraction of that size.13

As the amount and scope of capital controlled by Sovereign Wealth Funds has grown,so too has the concentration of leading SWF players. The top 10 funds ranked by AUMtoday control roughly 85 percent of total SWF assets, with oil exporters managing roughly

two-thirds of the capital deployed by the largest funds.

14

10 Preqin Investor Intelligence Profile, August 12, 2010.

Seven countries from threegeographic regions control the worlds largest Sovereign Wealth Funds: Saudi Arabia, the

11Sovereign Wealth Funds: A Bottom-Up Primer, JP Morgan Research, May 22, 2008.12Estimates based on marketplace data aggregated by the Sovereign Wealth Fund Institute at swfinstitute.org.13Simon Johnson, The Rise of Sovereign Wealth Funds, International Monetary FundFinance and Development,

September 2007.14Edwin Truman, A Blueprint for Sovereign Wealth Fund Best Practices, Peterson Institute for International

Economics Policy Brief, April, 2008.


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United Arab Emirates and Kuwait in the Middle East and Gulf region; Norway and Russia

in Europe; and China and Singapore in East Asia.15

The Persian Gulf

Sovereign Wealth Funds in the Middle East and Persian Gulf constitute the largest shareof total SWF assets under management of any region, with 44 percent of total holdings, or

$1.42 trillion, according to the Sovereign Wealth Fund Institute.16 The largest regionalinvesting powers are the Abu Dhabi Investment Authority ($627 billion), and the Saudi

Arabian Monetary Agency ($431 billion). Kuwait is also a large player in the Gulf with aprojected $202 billion in AUM.17

In recent years, ADIA has disclosed partial information on its holdings and offered anumber of media interviews with senior officials, including its late Managing Director,

Sheikh Ahmed Bin Zayed Al Nehayan.

As noted previously, the funds origin derives from theirimmense oil surplus, constituting both an attempt at greater income diversification and aninstrument to mitigate the sometimes volatile oscillation of global oil prices.

18

In 2009, ADIA published its first annual reportoutlining its investment strategy, portfolio overview, and recent investment activities.ADIA disclosed that 60 percent of the funds assets were in index-replicating strategies.About 80 percent of its portfolio is invested with external asset managers. Between one-

third and one-half of the fund was invested in North America, with the rest scatteredamong Europe, developed markets in Asia, and emerging markets.19 Before his death in a

plane accident in 2010, the Sheikh told the German business daily Handelsblattthat thefund would continue to take a long-term view on its investing strategy and wouldemploy controls that act as a brake on excessive risk taking during bull markets. The

Sheikh indicated that historically ADIA allocated between 40 to 60 percent of its capital inglobal equities, 15 to 30 percent in fixed income, and the remainder in real estate, private

equity, infrastructure, and alternative investments.20

The Saudi Arabian Monetary Agency, while controlling assets for investment, is

actually the Saudi central bank and tends to be more conservative in its allocation strategythan SWFs. Brad Setser, formerly of the Council on Foreign Relations, is one of the

worlds leading experts on Sovereign Wealth Fund investment and allocation strategies.He uses estimates of oil prices and national sales to measure the size of SWF holdings.Using this technique, Setser estimates SAMA has $400 billion in bonds and deposits,representing the preponderance of the funds assets. According to market research

provider Preqin, SAMA does not make private equity investments.

21

15

Richard Cookson, For A Few Sovereigns More: Sovereign Wealth Funds and the Changing Balance ofPower in Financial Markets and the World Economy, HSBC Global Research, February, 2008.16The Sovereign Wealth Fund Institute material is online at www.swfinstitute.org.17Private institutional investment estimates.18Inside the Abu Dhabi Investment Authority, by Emily Thornton and Stanley Reed, Business Week, June 6,

2008.19Abu Dhabi Investment Authority,ADIA Review 2009.20Handelsblatt, Interview with ADIA Managing Director, January 11, 2010.21Preqin Investor Intelligence Profile, April 21, 2009.


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Europe

The largest SWF in Europe is the Government Pension Fund of Norway. Like SovereignWealth Funds in the Gulf and Middle East, it derives most of its capital from oil revenuesand has benefitted from record price levels in recent years. Norway has arguably the most

transparent SWF in the world, releasing returns, asset allocations, quarterly returns, andprojections. They also explicitly make investment decisions based on therecommendations of an ethics council, guidance which has resulted in divestment from anumber of companies. About 60 percent of the funds assets are invested in global

equities.

East Asia

The dominant Sovereign Wealth Funds of East Asia, most notably those launched byChina and Singapore, were created to manage the accumulated foreign currency reserves

in excess of balances necessary to maintain exchange rate controls. Although both China

and Singapore now use a managed float exchange rate regime, both countries funds havesurvived and grown considerably. Chinese (including Hong Kong) and Singaporeanfunds now control over $1 trillion in AUM.

Singapore has two Sovereign Wealth Funds, Government of Singapore InvestmentCorporation (GIC) and Temasek Holdings. Each fund publishes an annual report

disclosing selective investment information.22GIC, which is wholly owned by theSingaporean government, was established in 1981 and is widely regarded as among the

worlds most sophisticated global Sovereign Wealth Funds, with offices worldwide inSingapore, Beijing, Shanghai, Seoul, Tokyo, Mumbai, London, New York and SanFrancisco. Similar to most other SWFs, media reports indicated that GIC experienced adecline in the value of equity investments in 2008 and 2009.23 In 2010 the funds AUM

resumed strong growth and is today projected to be $315 billion24

Temasek has enjoyed strong growth since its inception in 1974 as an entity whose soleshareholder is the Singapore Ministry of Finance. In the year 2007, before the financialcrash, the value of Temaseks portfolio reportedly grew 35 percent and included a range ofglobal investments such as Standard Chartered Bank, ABC Learning Centers (Australia),

Intercell AG (Austria), Country Garden and Yingli Green Energy (China), INX Media(India), Mitsui Life (Japan), and PIK Group and VTB Bank (Russia).

25 Temasek is run byHo Ching, the wife of Singapores Prime Minister and daughter-in-law of Singaporefounder Lee Kuan Yew.26 Temaseks AUM is estimated to be $186 billion.27

In China, national investment entities are funded and controlled by the government.

As previously noted, the State Administration of Foreign Exchange (SAFE Investment

22Report on the Management of the Governments Portfolio for the Year 2007/08.23 Singapores GIC Assets Drop 25% from Peak, Straits Times Says, Andrea Tan, Bloomberg, March 4, 2009.24 Preqin Investor Intelligence Profile, 2010.25State Capitalism: The Rise of Sovereign Wealth Funds, Oxford Analytica, 2007.26Singapores Temasek Says Goodyear Not Taking CEO Role, Reuters, July 21, 2009.27 Preqin Investor Intelligence Profile, 2010.


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Company), established in 1997, manages an estimated $347 billion. SAFE is specifically

mandated with Chinas foreign exchange holdings, while CIC was originally funded by abond issuance, the proceeds of which were then used to purchase $200 billion in foreign

reserves. CIC is estimated to have a total AUM of $332 billion.28

Both CIC and SAFE have a mandate to invest globally to boost Chinese Foreign DirectInvestment (FDI), which has historically lagged behind the United States. During 2009,Chinese companies invested $48 billion overseas, contributing to total accumulated FDI of

$211 billion, equal to about 4.3 percent of Chinese GDP. In 2009 American companiesinvested $340 billion internationally, for a total accumulated FDI estimated at $3.245

trillion, about 23 percent of U.S. GDP.

29

CIC has three different investment departments. The Central Huijin InvestmentCorporation manages domestic financial investments. The China Jianyin InvestmentCompany manages domestic assets and the disposal of non-performing loans. A third

department manages foreign investments. Based in Beijing, CIC is expected to employmore than 1,000 employees when it is fully operational, including 100-200 investment

specialists.

30In the summer of 2010, CIC initiated a round of global recruiting to supportits business development plans, seeking 64 investment professionals in a range of areasfrom asset allocation and asset management to private equity.31

Diversity of Fund Size and Investment Strategies

As noted previously, Global Public Investors vary enormously in their size, funding

source, and investment strategies. In recent years, market research suggests the largestSWFs have invested 50 to 55 percent of their portfolio in developed world stocks, withsmaller proportions in fixed income, real estate and other alternative assets, including

private equity and hedge funds.32

Sovereign Wealth Funds financed by petroleum profits have a different predilectionfor their investment strategies. The commodity-based funds of Norway, Russia, and the

Gulf operate, in a sense, as national endowments, storing wealth for a time when their

In contrast, analysts Brad Setser and Rachel Ziembabelieve the preponderance of assets held by the Saudi Arabia Monetary Agency to beinvested in conservative, dollar-denominated bonds rather than riskier assets subject to

market fluctuations. Financial services were heavily favored in 2008, with large infusionsby SWFs in Singapore, China, and the United Arab Emirates in American banks after thebeginning of the subprime crisis, as well as substantial investments by ADIA in leadingfinancial institutions. Other Global Public Investors, such as Chinas SAFE, have favored

different asset classes, investing excess foreign exchange reserves most aggressively insovereign debt instruments, especially those issued by the United States.

28 Preqin Investor Intelligence Profile, 2010.29Ken Miller, Coping With Chinas Financial Power: Beijings Financial Foreign Policy, Foreign Affairs, Vol.

89, No. 4 (July/August 2010).30Preqin Investor Intelligence Profile, August 12, 2010.31Bloomberg News, July 27, 2010.32JPMorgan Research, Sovereign Wealth Funds: A Bottom-Up Primer, May 22, 2008.


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mineral resources may be less plentiful. This strategy works to smooth consumption over

periods of low prices. For small yet oil-rich states, this type of forward looking strategyencourages revenue diversification among a broad array of asset classes to reinforce an

easier transition to a post-oil economy.

Long-Term Investment Horizons and Impact of the Financial Crash

Private discussions with a range of senior professionals associated with Global PublicInvestors produced a common theme. Both investment professionals from within state-sponsored entities and the investment bankers and analysts who cover such institutionscharacterized the orientation of GPIs as one focused on the long-term investment horizon.

Some GPIs in fact model their asset allocation and investment strategies on inherentlyconservative assumptions consistent with the mandate of a well managed pension fund

that eschews short-term profit-taking, seeks to mitigate market risk, prioritizes capitalpreservation and acquires assets with extended investment durations.33The Abu DhabiInvestment Authority, for example, has publicly stated its view that the countrys short-term horizon is at least three to five yearsforward, a view which allows asset managers to

look past immediate market fluctuations.34

The financial crisis imposed significant pain on state investment entities as it did topublic investors around the world. Norway reported a 23.3 percent decline in 2008, while

GIC of Singapore was reported to have lost 24 percent of its value.

For GPIs and Sovereign Wealth Funds thathave historically invested hundreds of billions of dollars in the private equity industry, it

is an established expectation that so-called General Partners (GPs) who invest the capitalof Limited Partners (LPs) may take years to acquire a company and as much as five toseven years beyond that to engineer an exit that will realize capital gains which in turn

will be returned to investors. The long-term horizon favored by most Global PublicInvestors, however, does not insulate them from the shock of short-term losses, which arepolitically charged domestically because of the perceptionand indeed the realitythatnational wealth has been diminished.

35Temasek Holdingsreportedly suffered a 31 percent loss between March and November of 2008.36

33

This conclusion is also consistent with the work of Brad Setser, Sovereign Wealth and Sovereign Power:The Strategic Consequences of American Indebtedness, Council on Foreign Relations Report, September,

2008.

AnalystsSetser and Ziemba projected that major losses were sustained by ADIA, the aggregatevalue of which they claim declined from $453 billion in December 2007 to $328 billion in

December 2008, although they acknowledged that these estimates were based on theassumption that around 60 percent of ADIAs portfolio was held in equities. Since then,

ADIA has indicated that its equity holdings during this period were actually closer to the

34Inside the Abu Dhabi Investment Authority, by Emily Thornton and Stanley Reed, Business Week, June 6,

2008.35Singapore Left with 2ndLargest Citi Stake, John Burton and Jamil Anderlini,www.sott.net,February 27,

2009.36Temasek Mulls Opportunistic Mining Investments, Netty Ismail and Jesse Riseborough, Bloomberg,

March 24, 2009.
http://www.sott.net/http://www.sott.net/http://www.sott.net/http://www.sott.net/


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lower end of its 40 to 60 percent range. The valuations cited are considerably lower than

the current estimate of $627 billion for ADIAs AUM cited by other research sourcestracking Sovereign Wealth Funds.

Setser and Ziemba found that for Persian Gulf Sovereign Wealth Funds, portfolio

decisions depend largely on oil prices. Their report postulates an elasticity of demand forforeign assets with respect to the price of oil. According to their analysis, oil must average$75 dollars a barrel for the total amount of foreign asset purchases to remain positive

beyond domestic expenditures. They find that after the crash of 2008, SAMA of SaudiArabia became the largest regional buyer by share of foreign assets, probably due to their

more conservative portfolio allocation and huge oil reserves.37

In another study of how Sovereign Wealth Funds responded to the financial crash, theMonitor Institute reports that some funds pulled back to invest at home.

38The ExecutiveDirector of the Qatar Investment Authority (QIA), Hussain al Abdulla, announced that

after losses suffered in 2008, QIA would exercise caution in its new internationalinvestments.39

For state investment entities dependent on natural resources revenues, governmentcapital infusions remain linked to commodity prices. In particular, the Gulf States,Norway, and Russia have all seen their revenue streams fluctuate, depending on the priceof oil, which has both climbed and declined over the past several years.

SAFE investments in international oil companies have been purely financial, with no

controlling stake in actual concessions or the development of new oil resources. In fact,

SAFEs investments in Western oil companies do not exceed 1 percent of any businesss

publicly available shares. Similarly, in 2008 CIC made portfolio investments in Total

which did not give them control over management or production decisions.

Cautious Investors after the Crash

A number of Sovereign Wealth Funds, responding to a decreased risk appetite after the

crash, switched to big Treasury purchases as asset managers reallocated out of equities.40Some foreign government central banks lost confidence in big Western financialinstitutions.41The net effect was a major withdrawal of foreign capital funding from global

banks.42

37GCC Sovereign Funds: A Reversal of Fortune, by Brad Setser and Rachel Ziemba, Council on Foreign

Relations, January 2009.

Chinas CIC reacted to the financial collapse by shifting investments toward

38

Monitor Institute, Weathering the Storm: Sovereign Wealth Funds in the Global Economic Crisis of 2008,SWF Annual Report, April, 2009.39Vernon Silver and Henry Meyer, Sheikh Who backed Barclays Gets Another Shot With Qatars Money,

Bloomberg News, May 11, 2009.40Landon Thomas, Jr., Sovereign Funds Now Prefer Hoarding Cash to Rescuing U.S. Financial Firms, New

York Times, October 14, 2008.41Heather Timmons and Keith Bradsher, To Avoid Risk and Diversify, Sovereign Funds Move on From

Banks, New York Times, September 19, 2008.42Stanley Reed, Sovereign Wealth Funds Take a Big Hit, Business Week, December 31, 2008.


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hedge funds and re-insurance companies.43After the crash, it directed renewed

consideration of investments in industries with long-term strategic value to Chinaseconomy, such as the mining and minerals sector.44

Not all of the market reverberations from the financial crisis were negative. Sovereign

Wealth Funds that held their ground and did not liquidate their equity positions in thefinancial industry during the crash and subsequent recovery ultimately made money. In2009, Kuwait announced that it had made $1.1 billion on its $3 billion Citibank stock

purchase of January 2008, representing a net gain of 37 percent on an annualized basis.Singapore and Qatar also reaped sizeable gains. Singapores GIC, for example, made a

$1.6 billion profit in 2009 after it sold half of its Citibank stock.

45And Qatar reaped a gainof over $1 billion on its investment in Barclays.46

In the end, their capacity to sustaindramatic swings in market volatility and an adherence to a long-term investment horizonserved many Sovereign Wealth Funds well.

Politics and SWF Investment

The common characteristic of foreign government ownership or management of

Sovereign Wealth Funds and other state entities that deploy capital on a global basis hasprompted some observers to question whether geopolitical interests influence investmentdecisions. For example, Chinas enormous surge in global investments in mining, minerals

and energy assets is seen by some as a new, defining feature of its foreign policy. Othershave similarly questioned whether American interests are threatened by foreign

investment in key American institutions or essential infrastructure. The strong andimmediate reaction of the American public, and subsequently that of Congress, in thespring of 2006 to the proposed takeover of six American ports by DP Worldand the

battle the year before between Chevron and the China National Offshore Oil Corporation(CNOOC) for energy company Unocalillustrates the continued sensitivity to foreigninvestment in what are perceived to be strategic American assets.

The geopolitical and strategic rationale for foreign direct investment by SovereignWealth Funds and other state actors is an entirely legitimate subject of analysis. Whilesome state investing entities in China are particularly focused on the energy and naturalresources sector, it is difficult to discern an overt political agenda in the investing activities

of the worlds most prominent Sovereign Wealth Funds and Global Public Investors,which are increasingly managed by western-trained investment professionals or are

partnering with North American and European institutions.

The United Arab Emirates, for example, conducts business with all of the major

investment banks around the world, and is regarded as an apolitical investor withprofessional and largely conventional investing objectives. ADIAs new Chief Investment

43Tina Wang, Chinas Sovereign Wealth Fund Turns Inward, Forbes.com, September 19, 2008.44Dexter Roberts and Fredrik Balfour, Chinas Shopping Spree, Business Week, July 27, 2009.45Eric Dash, Big Paydays for Rescuers in the Crisis, New York Times, December 7, 2009.46Julia Werdigier, Qatar Takes Profit on a Stake in Barclays, New York Times, October 20, 2009.


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Officer for private equity is a Wall Street veteran, James Kester, who was educated at

Cornell University and earned his MBA from the Wharton School at the University ofPennsylvania.47Other recent hires for ADIA include Ted Chu, chief economist at General

Motors as chief economist, and Bill Martin, former Chief Risk Officer at Commonfund and

currently Chairman of the Global Association of Risk Professionals, as chief risk officer.The Korean Investment Corporation, established in 2005 and modeled on SingaporesGIC, manages $37 billion and has an American, Scott Kalb, as its Chief Investment Officer.

Kalb is a former hedge fund manager at Tudor Investments who has emphasized hisintention to diversify KICs portfolio beyond its 90 percent concentration in public market

investments by expanding into new asset classes such as private equity, real estate, creditand distressed debt.48

The Qatar Investment Authority, which holds an estimated $85 billion in AUM, madea commitment in 2008 to the Qatar-UK Clean Technology Investment Fund, which was

established as a partnership between Qatar Investment Authority and Carbon TrustInvestments.

49The Canada Post Pension Plan, a state retirement fund with $14.5 billion of

AUM, late last year was reported to be partnering with the Ontario Municipal EmployeesRetirement System and Singapores GIC to invest in the Bluewater shopping mall, one ofthe largest commercial real estate assets in Britain.50

Pattern of Avoiding Controlling Equity Stakes

Sovereign Wealth Funds and state investing authorities typically do not take controlling

stakes in Western companies. Their equity interests in private companies are generallymanaged by general partners who invest their capital, such as the Carlyle Group, the $97

billion private equity firm, or other large global players such as KKR, TPG and Apollo.

The largest direct investments in Western financial institutions made by GIC, Temasek,CIC and others were non-controlling, minority stakes. Recently, SWFs taking large stakesin public companies have reportedly forfeited board representation and voting rights in

an effort to show they were not interested in interfering with day-to-day management ofcompanies. An anonymous survey conducted by Investors Dailyin February 2009 citedfund executives who voiced similar positions, saying We have no interests in controllingassets.51The Monitor Institute report in fact noted the disadvantages to such a posture,

observing that the principlesbehind shareholder capitalism require that public ownershold directors accountable.52

47

Paul Clarke, Who Is James Kester, ADIAs New CIO For Private Equity?, efinancialcareers-gulf.com48Tomoko Yamazaki and Komaki Ito, KIC Plans More Joint Ventures With Sovereign Funds Next Year,

Bloomberg, November 29, 2010.49Private Equity industry reports, as shared by a participant in the Brookings Project on Global Public

Investors.50Graham Ruddick, Bluewater Attracts Overseas Bids, The Telegraph, November 6, 2010.51Charles Watson, Cashed up Sovereign Wealth Funds Wait for Bottom, Investor Daily, February 26, 2009.52Monitor Institute, Weathering the Storm: Sovereign Wealth Funds in the Global Economic Crisis of 2008,

SWF Annual Report, April, 2009.


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Varying Levels of Fund Transparency and Disclosure

Despite an increased integration of western senior investment professionals and advisersamong Sovereign Wealth Funds, one of the issues that continues to exacerbate politicalsensitivity in some countries is the varied level of transparency and disclosure across

funds.53 Some funds disclose detailed information about their investment philosophy andallocation strategies, while others do not. As Gerard Lyons of Standard Chartered BankGlobal Research observes, the asymmetry of information creates uncertainty for

policymakers.54

Edwin Truman of the Peterson Institute for International Economics has writtenextensively on Sovereign Wealth Funds and has created an index to measure relativedegrees of SWF transparency.

55

In an effort to provide greater transparency, the China Investment Corporation filed avoluntary report with the U.S. Securities and Exchange Commission regarding its

American holdings. CIC indicated that one-quarter of its $9.63 billion invested in theUnited States as of December 31, 2009 was in exchange-traded funds, mainly in thecommodity and various sector funds. Since the last Peterson Institute rankings, ADIA,GIC, and Temasek have published annual reports detailing investment priorities and

allocations. Based on these filings, Truman has raised his transparency scoring for someof these countries, including ADIA.

His original index (compiled before several of the fundsreleased further information) scores 33 questions in the areas of structure, governance,accountability, and behavior. Of national funds, Norway scores the highest ontransparency with 94 percent of possible points awarded.

The focus on transparency among Sovereign Wealth Funds was stimulated in part byU.S. policy following the DP World controversy. According to a former TreasuryDepartment official, the administration of George W. Bush developed a three-part

strategy. First, the administration sought to demonstrate to Congress that it was beingresponsive to the concerns posed by Sovereign Wealth Funds. Second, the administrationmade direct efforts to engage SWFs to better understand their perspective on globalinvesting. Third, the Bush administration wanted to be the catalyst for a multilateral

process to develop best practices on transparency and disclosure.56

By 2008 the Bush administration had realized the core objectives of its strategy, mostsignificantly by aligning with the International Monetary Fund in its sponsorship of the

first multilateral dialogue on voluntary disclosure practices for Global Public Investors.The IMF working group produced what came to be known as the Santiago Principles

53

Edwin Truman, Sovereign Wealth Funds: Threat or Salvation?,Washington, D.C.: Peterson Institute forInternational Economics, 2010.54Gerard Lyons, State Capitalism: The Rise of Sovereign Wealth Funds, Standard Chartered Bank Global

Research, October 15, 2007.55Edwin Truman, A Scoreboard for Sovereign Wealth Funds, Peterson Institute of International Economics,

October 19, 2007; Edwin Truman, A Blueprint for Sovereign Wealth Fund Best Practices, Peterson Institute

for International Economics, April, 2008; and Edwin Truman, Sovereign Wealth Funds: Threat or Salvation?

Peterson Institute for International Economics, September, 2010.56Private briefing to Brookings Project by former Bush administration Treasury Department official.


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for Sovereign Wealth Fund transparency and disclosure.57

A recent study by Sven Behrendt of the Carnegie Endowment for International Peaceexamined the record of compliance with the Santiago Principles. He found that eighteen

months after the publication of the Santiago Principles, their implementation is highlyuneven. According to Behrendts study, a number of countries have made a strong

commitment to implementing the principles, while others have only partially fulfilledthem.

The principles were formally

adopted in October 2008 by 24 nations and most of the worlds leading SWFs. Among thekey principles were commitments to ensure better transparency, best practices on risk

management, and guidelines for decision-making processes that preserved appropriate

levels of independence from sponsoring governments.

58

Some funds have been slow to implement the Santiago Principles because they viewtransparency as inimical to their commercial interests and seek to preclude competitors

from gaining access to proprietary information. These state investors see little upside inbroad public disclosures but rather perceive real competitive risks in enhanced

transparency. Other state investors discount the competitive risks of greater disclosureand consider transparency to be an ascendant and stabilizing norm in the internationaleconomy.

59

Positive feedback loops through transparency ratings from trusted brandswould encourage GPIs to be more open about their actions.

The American Infrastructure Crisis and Foreign Capital

It is an undeniable fact in Americas fiscal and political debate that the nations publicsector faces a drastic shortage of capital. The current federal budget deficit alone isprojected to run about $1.5 trillion. Aggregate public debt grew 50 percent between 2000

and 2007 and at the close of 2010 has climbed to about $13.5 trillion, equal to 94 percent ofGDP, up from 51 percent in 1988. Interest on the national debt reached $414 billion inFiscal Year 2010, one of the largest expenses in the federal budget following national

defense and international security spending, Social Security and Medicare. The growingU.S. fiscal crisis has myriad implications, the most obvious of which is the absence ofresources to fund vital public needs, including infrastructure renewal.

The roots of the infrastructure crisis run deep. The transportation, energy and social

infrastructure of the United States is suffering from decades of underinvestment. Fromthe 1950s to the 1970s, approximately 3 percent of Americas GDP was allocated to

infrastructure. Since the 1980s, it has been less than 2 percent. By contrast, Japan spends 6percent of its GDP on infrastructure, South Korea devotes 5 percent, and Australia aims

57International Working Group of Sovereign Wealth Funds, Sovereign Wealth Funds: Generally Accepted

Principles and Practices, October, 2008.58Sven Behrendt, Sovereign Wealth Funds and the Santiago Principles, Carnegie Endowment for

International Peace, Number. 22, May, 2010.59Private not-for-attribution briefings provided to the Brookings Institution Project on Global Public Investors.


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for 4 percent.60

The consequences of underinvestment in infrastructure are pronounced and wide-ranging. Today, more than one-quarter of Americas bridges have been judged

structurally deficient or functionally obsolete.

61In the state of Pennsylvania alone, there

are over 6,000 structurally deficient bridges.62 According to a July 2008 report from theAmerican Association of State Highway and Transportation Officials, bridges are typicallydesigned for a 50-year life, but the average age of U.S. bridges in now 43 years.63

According to the United States Department of Transportation, between 1982 and 2005hours of traffic delays per traveler tripled, with 2.9 billion gallons of fuel wasted annually

as a result of vehicle congestion.64 Power outages and power quality disturbances on ournations aging and bottlenecked power grid are estimated to cost the U.S. economy

between $25 billion and $180 billion annually.65

While the federal government supports planningand in some cases

mandatesmany infrastructure programs, the responsibility for implementation andfinancing falls largely to state and local government, which typically have funded such

spending with municipal debt. Similar to most of the private sector, in recent years stateand local governments have relied heavily on ever-higher levels of debt. Total municipaldebt outstanding in the U.S. has increased at a compounded annual growth rate of 8.1percent since 2000 to nearly $2.5 trillion. The recent dislocation inflicted by the economic

downturn and the recession has decimated state revenues, slashed budgets and placedsevere pressures on borrowing in many states. As a result of these mutually reinforcingdynamicsmammoth development costs correlating with unprecedented publicdebtthe need for alternative sources of capital for U.S. infrastructure investment has

become self-evident.

Through much of the 20th century, state and local finance meant access to the

municipal bond market. In recent months, however, investors have been withdrawingmoney from municipal bond investment funds, a trend that is likely to accelerate overgrowing concerns about the solvency of many states struggling with acute budget deficits.

That trend would be exacerbated by the adoption of a measure proposed by the federaldeficit commission, which has called for the elimination of the tax exemption of interest on

municipal bonds, which in turn would end the subsidy that Washington now provides totaxpayers who invest in state and local debt securities. Finally, voters today are unlikely toapprove many new bond acts and elected officials who use borrowing methods that skirt

60Greg Coombs and Chris Roberts, Trends in Infrastructure, Australian Treasury Department, 2007.612009 Report Card for America's Infrastructure, American Society of Civil Engineers, March 2009.62Pennsylvania Department of Transportation website:http://www.dot.state.pa.us/internet/web.nsf/secondary?openframeset&frame=main&src=infobridge?openform

.63Bridging the Gap: Restoring and Rebuilding the Nations Bridges, American Association of State Highway and

Transportation Officials, July 2008.

64The Path Forward Funding and Financing Our Surface Transportation System - Interim Report of the National

Surface Transportation Infrastructure Financing Commission, U.S. Department of Transportation, February 2008.652009 Report Card for America's Infrastructure, American Society of Civil Engineers, March 2009.
http://www.dot.state.pa.us/internet/web.nsf/secondary?openframeset&frame=main&src=infobridge?openformhttp://www.dot.state.pa.us/internet/web.nsf/secondary?openframeset&frame=main&src=infobridge?openform


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voter approval do so at their peril. As a result the historical foundations of state and local

capital formation are fading away.

In the last few years, a paradigm shift has emerged in which many agencies and

departments of state and municipal government around the country have begun to

explore partnerships that seek to align the investment objectives of the private sector withthe policy objectives of the public sector in the long-term, successful delivery andoperation of infrastructure facilities and services. This financial model, known generally

as a public-private partnership, has long been the preferred framework for infrastructureprocurement in the developing world, often used to spur foreign direct investment, and

has become a major program in many developed nations, in particular the UnitedKingdom, Australia and Canada. Indeed, most policy pronouncements about the need foradditional investment in infrastructure in the United States are coupled with a call for theleveraging of private investment, as President Obama did in his 2011 State of the Union

address.

There are many precedents for foreign investment in U.S. infrastructure assets. Foreign

governments have been indirect investors in U.S. infrastructure via federal governmentbonds, which have been used to fund many infrastructure projects. More directly, foreigninvestors have been awarded long-term highway leases. Canadian and Australian public

pension funds and European infrastructure developers have invested their own capital aswell as the capital of infrastructure funds composed of limited partners including,typically, major institutional investors, both domestic and foreign.

Significant Sovereign Wealth Funds and other Global Public Investors have publicly

expressed support for a major program of American infrastructure renewal and haveindicated a potential interest in deploying capital in appropriately structured minority

investment vehicles. Zhou Yuan, head of asset allocation for the China Investment

Corporation, told the BBC news service in November 2010 that the Obama administrationshould spend $1 trillion on infrastructure over the next five years. At a New York meetingof the Chinese Financial Association, Yuan said that the CIC was urging the U.S.

government to form a public-private partnership to create super high-voltagetransmission lines and high-speed links between American cities, potentially creating500,000 high-paying manufacturing jobs. Yuan suggested that CIC could be a potentialinvestor in such a U.S. infrastructure initiative. If the conditions are right, and if, on a riskreturn basis, we believe this is a good investment, then yes, Yuan said, adding: But of

course we want to emphasize the fact that we are going to be a passive investor. Were nothere to run anything or to own anything.66

66China SWF Pushes Obama to Invest in Infrastructure; Lou Jiwei Warns of Slowing Economic Growth,

assetinternational.com, November 3, 2010.

The possibility of foreign investment in U.S.infrastructure development was reportedly discussed in a January 2011 meeting between

President Obama and Chinese business leaders, including Lou Jiwei, Chairman of CIC.According to news accounts, the White House encouraged the exploration of potential


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Chinese investment in infrastructure assets.67

Infrastructure is an attractive asset class to many institutional investors. By its verynature, infrastructure is a lower yielding but typically stable, long-term investment with

predictable revenue streams, high switching costs for users and meaningful barriers to

entry for competitors. Institutional investors such as public pension funds with long-termliabilities have historically been attracted to the infrastructure investments for a portion oftheir portfolios asset allocation. It could be argued that the significant capital

accumulated in public pension funds, both domestic and international, as well as GlobalPublic Investors, aligns powerfully with the steady and predictable risk-adjusted returns

and potential government support associated with capital-intensive, large-scaleinfrastructure investment. That argument carries even greater resonance in light of thereality confronting U.S. policymakers and state and local governmentsthe sheer scope ofcapital demanded for comprehensive infrastructure investment far exceeds the capacity of

domestic institutional investors or sources of public funding. If the United States is trulycommitted to the imperative of infrastructure renewal, it should remain open to possible

sources of foreign capital investment.There are different mechanisms to facilitate the flow of foreign capital into the United

States to support the enterprise of infrastructure renewal that are consistent with

legitimate concerns about national security and the perceived political risk of foreigninvestment in assets considered critical and essential to the American economy. Ifproperly designed and with necessary controls, foreign capital represents a viablepathway for the United States to obtain the resources necessary for a program of

infrastructure enhancement that will pay significant long-term dividends for U.S.competitiveness.

U.S. policymakers can look to other developed economies, such as Canada and the

United Kingdom, which rely extensively on outside investor capital for infrastructuredevelopment, for model best practices to guide a comparable American program. Thespecific legal and financial structures through which such capital is invested vary

depending on the sponsoring government and the nature of the asset. However, nearly allsuch arrangements involve three factors: (i) an upfront investment of outside investor

capital, (ii) the expectation of a financial return to the investors over time, and (iii) thetransfer of at least some of the risks and rewards of ownership from the government to theinvestors.

In the most common form, these arrangements involve a national or local governmentgranting to an investor group a long-term concession for an infrastructure asset, such as ahighway, in exchange for a financial investment. The infrastructure assets involved can be

either existing facilities or so-called green field projects to be constructed as part of theconcession agreement. The investor group is typically responsible for maintaining andoperating the asset in accordance with standards stipulated in the concession agreement,

including the absorption of operating costs that may be greater than originally projected.

67Chinese Firms Set Sights on U.S. InvestmentsComputer Maker Lenovo Underlines Broader Interest;

White House Encourages Sovereign Wealth Fund to Take Stakes, by Rebecca Blumenstein and Laura

Meckler, January 27, 2011, Wall Street Journal Asiaand WSJ.com.


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At the end of the concession period, the investor groups rights and responsibilities revert

back to the government sponsor of the concession.

In recent years, Canada has been particularly active in leveraging outside investor

capital to fund infrastructure projects, including highways, bridges, hospitals,

courthouses, wastewater facilities and concert halls. By opting for private-publicpartnerships over traditional procurement methods, Canada and its provinces haveadvanced the countrys infrastructure development goals without tapping tax revenues or

increasing municipal debt burdens. According to a recent study by the Conference Boardof Canada, over 100 transactions have been concluded with private sector consortia in

Canada since the early 1990s.68

Other viable models of infrastructure investment have been established. Severalprivate infrastructure funds already exist that pool capital from multiple investors, bothforeign and domestic, including pension funds, sovereign wealth funds, endowments and

high net worth individuals. While fund governance mechanisms are rarely publiclydisclosed, they typically limit the role that a single investor can play to an advisory

capacity and minority status with no rights for operational control of infrastructure assets.An entity such as the proposed Infrastructure Bank, advocated by President Obama inSeptember 2010, represents yet another model to channel private capital investment.

69

Current models suggest the possibility of a national infrastructure investment vehicle

for the United States that could be structured as a peer institutional investor to domesticpublic pension funds. Sovereign Wealth Funds and other Global Public Investors could belimited partners, with no single fund or group of investment entities of a single countrypermitted to hold a controlling share. No foreign investor would exercise decision-makingauthority about the operation or management of infrastructure assets. Beyond the decision

to investand the customary right to serve on an investment committeeall foreign

entities would be passive minority shareholders. Through such a deliberate andtransparent structure, an investment pool of limited partners with both defined rights andrestrictions could decisively mitigate the risks of foreign investment in U.S. infrastructure

assets.

A vehicle for foreign investment in infrastructure development could deploy capital in

several non-exclusive and mutually reinforcing ways. Such an entity could invest inprivate infrastructure funds which meet its investment objective. It could invest side-by-side with private infrastructure funds. It could make direct investments or it couldpartner with operating companies. In several recent larger transactions, multiple sources

of equity have partnered, and a foreign investment vehicle in infrastructure assets couldparticipate in the formation of these larger pools of equity required for what are often very

large projects.Along with other institutional investors and private funds, an infrastructure

investment vehicle could coordinate with current and future federal programs that

68Dispelling the Myths: A Pan-Canadian Assessment of Public-Private Partnerships for Infrastructure

Investments, The Conference Board of Canada, January, 2010.69William Galston, Infrastructure Bank Proposal Would Spur Economic Growth, Brookings Institution,

September 7, 2010 and Bruce Katz, Innovation and Infrastructure, Brookings Institution, January 20, 2010.


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provide low-cost leverage for these equity investments. These programs could include

extensions or future versions of the Department of Transportations TIFIA loan programfor surface transportation, various forms of Private Activity Bonds and a National

Infrastructure Bank. A range of mechanisms could be fashioned that balances the needs of

foreign investors with requirements for the operational control and necessary ownershipstructure of U.S. infrastructure investments. The obstacles to such foreign investment arenot related to the flexibility and innovation inherent in modern forms of private-public

partnership for infrastructure development, which have produced effective modelsappropriated around the world. The obstacles are political, requiring the will and

imagination of policymakers and government officials.

Co-Investment in Low-Carbon and Energy Efficiency Technologies

Another investment vehicle for foreign capital is a proposed Green Bank known as theClean Energy Deployment Administration (CEDA). Under its original design announcedin 2009, CEDA would be funded with up to $10 billion from the Department of theTreasury that in turn would be used to guarantee $100 billion in revolving federally

backed loans, which advocates argued could be used to attract another $100 billion inprivate capital to accelerate deployment of smart grid technologies, renewable generation,

carbon abatement programs and nuclear power.70The Brookings Institution GrowthThrough Innovation Project has recommended that Congress and the Administrationseriously consider the creation of a Green Bank. By supporting the establishment of astanding entity which would considerably reduce the cost of financing for low-carbon

energy infrastructure, a Green Bank would stimulate job creation and advance thedevelopment of low-carbon technologies.71

It remains to be seen if the CEDA model would attract interest from Global PublicInvestors. But the proposal underscores the possibility of U.S. government co-investmentprogram comparable to SBIC financing sponsored by the U.S. Small Business

Administration and Investment Division. Such an initiative would align investments fromforeign state entities and the U.S. government in companies with viable technologies thathave not reached scale and are not currently served by the conventional project financemarket. By absorbing mezzanine finance risk, a structural gap that disadvantages green

technology companies from moving beyond the venture phase to broadercommercialization could be filled by both the U.S. government and GPIs.

Many nations recognize the need to innovate through new technology and to reducegreenhouse gases.72

70Peter Behr, Green Bank Proposals Probe the Hostile Frontier of Politics and Finance, Climate Wire, New

York Times and NYT.com. October 2, 2009.

Industries around the globe perceive long-term incentives in

developing and deploying pollution abatement technologies with the potential to generatenew jobs and unleash billions in private sector investment. Some Global Public Investors

have already staked out ambitious initiatives in the cleantech space. For example, the

71Strobe Talbott, Forum on Growth Through Innovation, Brookings Institution, November 23-24, 2009. 72Juliet Eilperin, EPA, Senate Take Aim at Greenhouse Gases, Washington Post, October 1, 2009.


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Mubadala Development Company of Abu Dhabi, a Sovereign Wealth Fund, is invested in

the cleantech sector through its Masdar renewable energy and sustainable technologyinitiative.

Promoting Effective Transparency and Accountability

The International Monetary Funds 2008 Santiago Principles call for improvements in the

disclosure of asset allocations, portfolio strategies, and investment priorities for theworlds diverse array of sovereign state investors. These voluntary guidelines promoted

by the IMF offer one way for an increasingly influential set of actors in the global economyto alleviate some degree of the misunderstanding that surrounds their investment

activities. Greater adherence to the Santiago Principles will not only help build confidenceamong investors, but also provide greater stability in global financial markets, as a 2008

Congressional Research Report concluded.73

Greater transparency with meaningfulincentives will strengthen the climate for sovereign investment in the United States andenhance understanding among American political elites.

Engaging the Political and Policy Communities and BuildingPartnerships with Global Public Investors

Given Americas need for global capital investment during a protracted period ofnecessary debt reduction, it is crucial to develop a national policy frameworkboththrough the private and public sectorsthat helps attract foreign capital. Because globalcapital is the ultimate fungible resource of the twenty-first century, a failure to ensure a

favorable and fully competitive environment for foreign sovereign investment will simply

mean that other countries and regions will benefit at the expense of the United States. Apredicate to building a national policy framework and investment partnerships withGlobal Public Investors is an enhanced understanding of their unique role in the globaleconomy and the potential they represent to the United States.

There is a recent history of worrisome developments in the United States that

complicates Washingtons relationship with Global Public Investors and Sovereign WealthFunds. One is U.S. protectionist sentiment in the aftermath of the financial crisis,

displayed by some political leaders in the form of buy American provisions in the 2009economic stimulus package and requirements that financial institutions receiving TARPmoney limit the number of foreign employees they bring to America on H-1B visas.74

73Martin Weiss, Sovereign Wealth Funds: Background and Policy Issues for Congress, Congressional

Research Service, March 26, 2008.

Legislative provisions that demand preferential treatment for U.S. companies and workers

encourage foreign countries to adopt the same restrictions. As the late Sheikh Ahmed BinZayed Al Nehayan of the Abu Dhabi Investment Authority observed, restrictions in cross-

74Darrell M. West, Brain Gain: Rethinking U.S. Immigration Policy, Washington, D.C.: Brookings Institution

Press, 2010.


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border investments compromise the worlds economic recovery and raise barriers to

future investment and growth.75

Another complication for foreign state investors, particularly Sovereign Wealth Funds,

is that in earlier periods, their strongest political advocates were large Wall Street banks, a

class of economic actors that has suffered enormous reputational damage in the aftermathof the crash. Global financial institutions made the argument that SWFs were valuablesources of new capital investment and crucial to international trade and commerce. But in

an era of financial regulatory reform, as Americas largest financial institutions have beenon the defensive and weathering populist attack, Wall Street advocacy for foreign capital

providers is a low priority that would be viewed negatively by legislators and the broaderpublic.

Not-for-attribution discussions with Global Public Investors reveal a discernible anddeep anxiety about the volatility of the American political system and significant concerns

about the lack of predictability in the regulatory and legislative domains. Uncertaintyabout the future tax regime applied to foreign capital has been corrosive, particularly with

respect to the tax treatment of foreign real estate and certain other forms of investment.Some foreign investors have been anticipating potential clawbacks resulting fromaltered tax provisions. The recent upheaval of the 2010 midterm elections and the rise of

the Tea party has only exacerbated a pervasive sense of uncertainty and perceivedpolitical and regulatory risk.

Compounding current tensions is the simple fact that many American political andpolicy elites today have little interest in or knowledge of, Global Public Investors,

particularly Sovereign Wealth Funds and State-Owned Enterprises.76

One possible means of alleviating the mutual lack of substantive understanding thatexists between American political and policy elites and Global Public Investors would be

to initiate a dialogue between these two very disparate constituencies. As noted in theintroduction to this report, one of the most important yet easily implemented

recommendations of this study is to create the Global Public Investors Roundtable, aninformal group of administration policy-makers from the White House, Treasury, Stateand Commerce Departments and a range of congressional actors and their staff from bothsides of the aisle in Washington who would meet with the worlds leading Global Public

Investors, Sovereign Wealth Funds and representatives of other international financialinstitutions on a periodic basis to share information and stimulate dialogue on economic,

regulatory, national security and political issues central to foreign investment in theUnited States.

That lack ofunderstanding is reciprocated by sovereign investors conducting business in the United

States, who lament the turbulence subsuming both the rules and rule-makers that will

govern potentially billions of dollars of deployed capital.

One of the themes the Roundtable dialogue might address would be current issues

75Handelsblatt, Interview with ADIA Managing Director, January 11, 2010.76Government Accountability Office, Sovereign Wealth Funds: Laws Limiting Foreign Investment Affect

Certain U.S. Assets and Agencies Have Various Enforcement Processes, May, 2009.


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relating to the policy review processand sometimes bitter politicsassociated with

foreign direct investment. The federal government Committee on Foreign Investment inthe United States (CFIUS) has jurisdiction over non-U.S. investment. It was created as an

inter-federal agency body in 1975 and was updated through the Foreign Investment and

National Security Act of 2007.77

It is composed of representatives from 14 federal agencies,including the Departments of Treasury, Justice, Homeland Security, Commerce, Defense,State, and Energy; the offices of the U.S. Trade Representative and Science and

Technology; as well as the Office of Management and Budget, Council of EconomicAdvisors, and Assistants to the President for National Security Affairs and Economic

Policy. According to the groups enabling order, the committee has primary continuingresponsibility within the Executive Branch for monitoring the impact of foreigninvestment in the United States, both direct and portfolio, and for coordinating theimplementation of United States policy on such investment.78 Typically, there is scrutiny

of foreign investment that aims to acquire 10 percent or more of the shares of anincorporated American business. Based on a 1988 amendment to the Omnibus Trade and

Competitiveness Act, the president may block any foreign investment deemed a threat toU.S. interests.79 Following notification of a purchase, CFIUS members have 30 days toreview the proposed deal and 45 days to investigate its national security implications. Thepresident then has 15 days to make a formal decision approving or prohibiting the

transaction.80

A greater understanding of the CFIUS processby Global Public Investors, Congress

and the broader publiccould alleviate concerns about sovereign investment in theUnited States. In the aftermath of the DP World and CNOOC cases various reforms wereproposed, a number of which would have been damaging to the U.S. economy withoutenhancing U.S. national security.

81

The GPI Roundtable could constitute one means of

convening a substantive dialogue with the potential to avoid conflict in the future.

Conclusion

Global Public Investors are increasingly central to aspects of the U.S. economic recovery, afact the Obama administration appears to be embracing. As noted previously, in late 2010and again in January 2011, U.S. and Chinese officials discussed a potentially significant

investment through CIC in U.S. infrastructure development. More recently, Washingtonreached out to Sovereign Wealth Funds such as GIC to probe interest in the acquisition of

up to $20 billion in shares of the insurer AIG, which was bailed out by the government at

77Joel Moser, Inbound U.S. Infrastructure Investment, Fulbright & Jaworski Briefing, April 22, 2010.78Executive Order 11858, May 7, 1975.79The so-called Exon-Florio Amendment is still the source of public policy debate. See Graham and Marchick,

US National Security and Foreign Direct Investment, pp. 33-58.80Congressional Research Service, The Committee on Foreign Investment in the United States, 7-5700,

February 4, 2010.81 Edward M. Graham and David M. Marchick, US National Security and Foreign Direct Investment(Institute For

International Economics, Washington, D.C. 2006).


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the acme of the financial crisis.82

Looking ahead, as the realities of Americas debilitating

deficits at both the state and federal levels become embedded into the political debate andits policymaking discourse, there will be an even greater impetus to explore the potential

role of Global Public Investors in foreign direct investment in the United States. While

there are self-evidently legitimate concerns about the form and structure of suchinvestment in sensitive asset classes of a strategic nature, there are also establishedgovernment mechanisms to evaluate such investment proposals and multiple models of

public-private partnerships around the world that demonstrate the ability to mitigatedefined risks and ameliorate political sensitivities. Given their international mandate,

increasingly sophisticated management practices and surplus of capital, there is apotential role for Global Public Investors to play in rebuilding America, including ininfrastructure development to the cleantech sector. It is the thesis of this report that suchopportunities should be exploredmethodically, thoughtfully, thoroughly and in

p

richard a. kimball, jr. - rebuilding america: the role of foreign capital and global public...

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